Goldman Vindicated as Swaps Traders Capitulate on Rates

By Blake Schmidt -
Nov 9, 2012

Swaps traders are capitulating to
Goldman Sachs Group Inc. (GS) as bigger-than-forecast declines in
wholesale prices prompts them to push out their bets on when the
central bank will raise interest rates.

Traders who wagered in October that the bank would boost
rates from a record low 7.25 percent as soon as April now
predict there won’t be an increase before July. Policy makers
cut the target rate for a 10th straight meeting on Oct. 10 and
said they would keep the borrowing costs stable for a
“sufficiently prolonged” period to revive the slowest growth
among the biggest emerging-market economies.

While the largest rate cuts among Group of 20 nations has
kept inflation above policy makers’ target of 4.5 percent for 26
months, the biggest decline in an index of producer prices in
three years is supporting an Oct. 26 call by Goldman Sachs’s
Brazil chairman Paulo Leme, who said the central bank won’t
raise rates before 2014. Barclays Plc (BARC) says lower producer prices
will ease pressure on inflation as speculation increases
President Dilma Rousseff’s government will turn to the exchange
rate and fiscal policy to keep consumer prices in check.

“The new normal is low rates for a long period of time,”
Marcelo Salomon, the New York-based co-chief of Latin American
economics at Barclays, who like Leme expects stable rates to
2014, said in a telephone interview. “You do tax exemptions on
the fiscal side instead of stimulating consumption and create an
environment so you don’t need to hike rates in 2013. There’s
less inflation pressure.”

‘Slower Recovery’

Goldman’s Leme, speaking at a Brazilian pension fund event
in Sao Paulo on Oct. 26, said developed nations face a “long
and painful” deleveraging process that will weigh on global
growth and provide room for Brazil to keep rates at record lows.

“I’m more dovish,” Leme said. He didn’t respond to calls
seeking further comment.

Banco Itau BB SA’s research team headed by chief economist
Ilan Goldfajn cut their forecast for the 2013 year-end Selic
rate to 7.25 percent in a monthly report e-mailed yesterday,
from 8.5 percent in the same report the month before.

“We previously believed that with a steadier economic
rebound, interest rates would bounce back in the second half of
2013,” the report said. “We now foresee a slower recovery.”

Keeping borrowing costs at record lows for a “prolonged
time” is still the best strategy to ensure inflation will slow
to the midpoint of the 2.5 percent to 6.5 percent target range
in 2013, central bank President Alexandre Tombini said in an
interview at his office in Brasilia on Nov. 7.

Stimulus Measures

The bank has cut its benchmark lending rate by 5.25
percentage points since August 2011 in a bid to stoke demand and
bolster growth that economists surveyed by Bloomberg forecast to
slow to 1.5 percent this year, from 2.7 percent in 2011 and 7.5
percent in 2010. The inflation-adjusted interest rate is still
higher than every G-20 nation apart from China.

The government has also extended tax cuts for consumer and
industrial goods, cut bank reserve requirements to boost
lending, pressured banks to reduce profit margins on loans and
increased public spending to stoke expansion.

The stimulus hasn’t taken hold in all parts of the economy.
Industrial output in September fell 1 percent from a month
earlier in the first drop in four months. Consumer default rates
in September held at the highest level since November 2009.

Market Expectations

“The economy hasn’t recovered any more than was
expected,” Carlos Kawall, the head of the economics department
at Banco J. Safra, said in a phone interview from Sao Paulo.
“The market should converge toward that expectation of a stable
Selic. We’re seeing movement in that direction in the swap rates
curve and the central bank survey.”

About 100 economists surveyed by the central bank forecast
the economy will grow 1.54 percent this year and 4 percent in
2013. The same economists lowered their forecast for the 2013
year-end benchmark rate for the second straight week in the
survey published Nov. 5 amid signs that the economy is
struggling to gain speed after a year-long slowdown.

Brazil’s Selic rate will be 7.63 percent at the end of next
year, according to the median estimate. Analysts had forecast
7.75 percent the previous week and 8 percent the week before
that. The top five analysts in the survey cut their year-end
2013 forecast to 7.25 percent, from 7.5 percent the week before.

Inflation Outlook

Jankiel Santos, the chief economist at Banco Espirito Santo
de Investimento in Sao Paulo, says the central bank will have to
raise rates by October 2013 to control inflation that will reach
5.5 percent next year. Rousseff’s plan to force power companies
to cut rates by as much as 28 percent, announced Sept. 11, won’t
be enough to keep a lid on prices, according to Santos.

“We’re still worried about inflation,” Santos said in a
phone interview. “Inflation won’t converge toward the target
midpoint this year or even next year. With low unemployment and
rising incomes, any price pressures from abroad will impact
domestic prices.”

The extra yield investors demand to own Brazilian
government dollar bonds instead of U.S. Treasuries fell two
basis points, or 0.02 percentage point, to 147 basis points at
1:38 p.m. in Sao Paulo, according to JPMorgan Chase & Co. (JPM)

The cost of protecting Brazilian bonds against default for
five years increased two basis points to 104 basis points,
according to prices compiled by Bloomberg. Credit-default swaps
pay the buyer face value in exchange for the underlying
securities or the cash equivalent if a borrower fails to adhere
to its debt agreements.

The real weakened 0.5 percent to 2.0508 per dollar. Yields
on interest-rate futures contracts due in January 2014 rose one
basis point to 7.35 percent.

‘Hawkish Interpretation’

The Getulio Vargas Foundation’s IGP-DI price index
decreased 0.31 percent in October from a month earlier, compared
with a median forecast of a 0.15 percent slide among 31 analysts
surveyed by Bloomberg.